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The Perth office market continues to soften, resulting in face rents starting to succumb to incentives of around 35% and in some cases up to 50%. The concept of maintaining artificially high face rents to preserve market values for ‘book values’ is unrealistic and only requires an increase in interest rates and/or a default in cash flow for the ‘commercial property deck of cards’ to come tumbling down.

Landlords are focusing on maintaining high face rents to reduce the impact on book value that increases a property owner’s borrowing capacity. It also ensures that face market rents are maintained in tenant rent reviews.

While face rent has represented a line in the sand for landlords, the incentives being sought by tenants are becoming financially unsustainable. This push in the market is a reflection of tenants trying to secure immediate cash flow relief through rent-free periods or contribution towards fitouts with the balance towards a shorter rent-free period.

However, with incentives averaging around 40% in the Perth CBD that line is rapidly becoming blurred as landlords with less diversified portfolios cannot match these level of incentives without rent abatement - the first sign that this formula is not only under strain, but is not sustainable.

There are signs that the landlord resolve is weakening in the face of the reality of an oversupplied market resulting in them reducing the face rent (particularly where there is a fitout in situ) while reducing and amending the structure of the incentive as a reflection of rent abatement throughout the initial term rather than total rent free.

The current Perth vacancy rate is at a five year high at 16.6% with more CBD stock coming onto the market as the construction of new buildings and developments – like King’s Square - is completed. We estimate there is some 155,860 sqm of office space under construction for delivery in 2015, for a net addition of 110,000 sqm. We estimate that it would take some 9000 plus city workers to absorb the additional space alone.

As these new buildings come online within the prevailing retraction of the resources sector and low iron ore and oil prices, we believe that the vacancy rate will cross the 20% threshold before the end of 2015 and will continue to increase through 2016. That provides some idea of the state of the still weakening WA jobs economy.

As the sublease market continues to grow, fair market transactions are being dictated by the volume and actions of tenants needing to relinquish surplus space in a market that continues to grow in vacancy. This is disrupting the landlord market and will ultimately drive lower face rents and higher incentives.

It will take time and improved economic conditions for that vacant space to be absorbed. We expect rents to be under continued pressure for at least two years unless something changes – like a commitment to new resource projects, increase in oil barrel prices and/or large State/Federal projects to encourage further migration into Western Australia.

In the meantime, the beneficiaries will be tenants who may never find a better time to negotiate great deals – either in lease renewals or in a “flight to quality”. However, in all negotiations, the devil is in the detail and tenants should always ensure that the commercial terms are not geared for short term gain that unintentionally deliver long term pain.

Tenants should make sure they are fully informed when making these commercial commitments and ensure they have the financial capability to meet their lease commitments once the incentives have dried up and are long forgotten.

The political tsunamis generated by the UK’s Brexit and the election of President Donald Trump have flooded through into the corporate world and focused the discussions of global commercial property leaders at the bi-annual ITRA conference in Paris recently.